Economic Systems

These refer to the way in which different societies solve the three different basic economic problems which are:

  1. Which goods should be produced and in what quantities?
  2. How should various goods and services be produced?
  3. How should various goods and services be distributed?

These in turn determine various political and economic structures in the society. The economic systems are as follows:
1.Free market economy Also referred to as capital system or laiser faire economy. It refers to a system where decisions about allocation of resources are made individuals on the basis of prices generated forces of market prices of demand and supply. A free market economy has the following features

  • Private property individuals have the right to own or dispose off their property as they may consider it fit.
  • Freedom of choice and enterprise Individuals have the right to buy or hire economic resources, organize them for production purpose and sell them in the market of their choice. Such persons are referred to as entrepreneurs.
  • Self interest the pursuant of personal goals. The individuals are free to do as they wish and have the motive of economic activity in self interest.
  • Competition There is a large number of buyers and sellers such that each buyer and seller accounts for but is insignificant to influence the supply and demand and hence prices.
  • Reliance on price mechanism This is an elaborate system of commerce in which numerous choices of consumers and producers are aggregated and balanced against each other. The interaction of demand and supply determine prices.
  • No government intervention Hence no price controls, taxes and subsidies.
  • There are property rights provided and enhanced the government through copy rights patents, trademarks etc.

Advantages of free market economy

  1. There is the matching of demand and supply. Production takes place in response to demand hence a balance between what is produced and consumed. No wastage.
  2. There is flexibility of the market in responding to changes in demand and supply conditions.
  3. There are no resources wasted in planning as no planning is required
  4.  Consumer sovereignty and competition gives rise to a wide variety of goods and services giving consumers a wide range to choice from.
  5. Higher rates of economic growth due to the incentive available for hard work which is motivated profits.
  6. No wastage of resources on unrealistic projects because investment decision are based on profits.

Disadvantages

  1. Income inequality the ability of some people and firms to acquire excessive market power leads to greater inequality in income and wealth.
  2. Monopoly power refers to the ability of a firm to control its prices
  3. Externalities spill over refers to social costs and benefits not taken into consideration when determining price levels.
  4. Public goods. The price mechanism on its own cannot allocate resources to the production of public goods such as roads, schools, security etc., which have no rivals and no excludability.
  5. Instability and unemployment due to the trade cycles of recession, depression, recovery and boom.
  6. The inability to deal with structural changes caused wars, natural calamities among others.
  7. Inadequate provision of merit goods. Merit goods are goods of importance to the community such as health, education, security among others

2.Planned economy Also referred to as command economy or government controlled economy, socialism or communism. It refers to an economic system where the crucial decisions are determined a body appointed the state. The body takes up the role of mechanism which prevails in a free market economy

Features of a command economy

  • Leadership and control of economies. All important means of production (resources) are publicly owned such as land, power generation, housing among others.
  • Rationing of certain commodities if supply of such fall bellow demand.
  • Existence of production targets for different sectors of the economy. The government determines how resources are allocated through planning.
  • Fixing of prices and wages
  • Occasional existence of restricted labour market in which workers take up jobs assigned to them.
  • Government decides what is to be produced

Advantage of planned economy

  • Avoids economic instability
  • Minimize negative externalities
  • Makes adequate provision of public and merit goods
  • Facilitate the shift of resources in pursuant of grand schemes such rapid industrialization
  • Puts checks on monopoly power which are controlled state monopolies (Parastatals).

Disadvantages of Planned economy

  • There is wastage of resources in production because consumers demand is judged in advance without the use of price mechanism.
  • The cost of gathering information for planning is expensive to the state.
  • In absence of profit motive in production there is no incentives for hard work and innovation.
  • The power of consumer sovereignty is curtailed

3.Mixed economy refers to an economic system where resource allocation is determined the state and price mechanism. This form of economic system can exist in two ways:

  • Where the means of production are privately owned but the government through fiscal and monetary policies regulate the working of price mechanism towards desired levels.
  • The government does not only regulate the working of the price mechanism but also strategic resource thus taking part in production.

Fiscal policy refers to the policies which the government uses to stabilize the economy through government revenue and expenditure.
Monetary policy refers to the policies implemented the central bank to stabilize the economy use of money supply and interest rates.
Both policies make up the budgetary policy of the government.

Why Intervene in the Economy

  • To create a framework of regulations and rules to ensure fair competition thus promote competition between firms both small and big.
  • Redistribute income through a system of taxation
  • Prevent market failure of price mechanism
  • Stabilize the economy
  • Maintain competition controlling monopoly

Partial Equilibrium refers to the study of the behaviour of individual decisions making units and the functioning of individual markets in isolation. General Equilibrium is the analysis of the behaviour of all individuals‟ decision making units on all individual markets simultaneously.

Specialization
This refers to the process where people concentrate on those activities where they are best at. It takes a form of division of labour which is dividing up of economic tasks of production into tasks which people specialize into. Division of labour therefore leads to specialization which leads to increase in output.

Advantages of specialization

  • It help individual development exploring their talent
  • It is possible to use machines to do specific/ particular task
  • Increase in skills result in increased expertise and performance
  • Time saving as a worker will accomplish more doing a particular task.

Disadvantages

  • Leads to loss of craftsmanship. Extensive specialization leads to increased use of machines which are more automated leading to loss of basic skills
  • Production of standardized goods limiting the range of goods consumers can choice from. It does not cater for different tastes and preferences.
  • Monotony and boredom due to repetitions of the same work. This leads increased accidents, absenteeism which are associated with lack of motivation.
  • Increased inter-dependence as a specialized system of production increases the extent to which different sectors of the economy rely on each other. If mistakes are made in one production unit it may cause the fall of all or other organization which depend on items from that production unit.
  • Increase in risk of unemployment if one’s skills are no longer required in the market they may get an alternative employment.
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